Donald Trump once famously proclaimed that “cash is king.” But as most small business owners know all too well, what he really should have said is “cash flow is king.”
Failing to understand and manage cash flow is the most frequently cited reason that a small business goes out of business. But a business doesn’t have to be failing to encounter problems. Even profitable firms can fall into a cash flow trap, and fast-growing firms are particularly vulnerable because their cash demands are that much higher.
So it should go without saying that managing cash flow should be a top priority. Yet one survey found that 46 percent of small business owners failed to list cash flow management as a major preoccupation or said they delegated the task to others — big mistake, according to experts.
A Common Business Quandary
At its most basic, cash flow is simply the amount of money that comes into a business versus the amount that flows out the door to pay bills. The problems arise because the two cash streams rarely match.
The dislocation can be as small as a few days, or it can be a question of months. A retail store, for example, may ring up most of its sales on Friday and Saturday. The rest of the week, it’s starved for cash. And most retailers, regardless of size, typically do 45 percent of their sales during the weeks between Thanksgiving and Christmas. The huge cash surplus must carry them for months — or at least until President’s Day.
In the meantime, they must continue to purchase inventory and meet payroll along with every other bill, from basic utilities to debt service. The same goes for most other businesses, from construction to plumbing contractors to computer services.
The simple solution, of course, is to have enough cash reserve on hand to get through periods of low cash flow. But the overwhelming majority of small businesses, especially startups, are typically undercapitalized.
To compound the problem, most banks still adhere to that old truism: They only want to lend you money when you don’t need it. Without cash reserves or a hefty line of credit at the local bank, the only other solution is to closely manage cash flow. And that process usually begins with a cash flow analysis.
Measuring and Managing Cash Flow
At its most basic, a cash flow analysis begins with cash on hand; that cash is used to create inventory and the inventory is sold to create receivables. Then more cash is created when the customer pays. Expenses can be projected against cash flow to yield an operating cash flow (OCF) ratio. The OCF ratio is important because it’s a measure of a company’s liquidity, or its ability to pay its bills.
After determining cash flow, the next step is to manage it. In real estate, as the saying goes, the three most important factors are location, location, location. The same goes for cash flow management. Except the three most important factors are organize, organize, organize!
It’s critical, experts say, to map out expenses in as much detail as possible. That starts with listing recurring expenses — insurance, utilities, lease payments, rent, payroll, capital goods, inventory — and, just as importantly, noting when they are due. The next step is to prioritize. Payroll, for example, must be met without fail. But most other payments are flexible. Vendors, for example, are often willing to accept terms.
The Cash Flow Contradiction
In real estate it’s also a truism that sellers always want top dollar for their properties while buyers always want to pay next to nothing. By the same token, Les Masonson, the widely quoted author of Cash, Cash, Cash: The Three Principles of Business Survival and Success, says cash flow is all about “getting the money from customers sooner [and] paying bills at the last possible moment.”
Therein lies the fundamental contradiction of cash flow management. This is where the fun begins. A cottage industry of experts offers reams of advice on tricks of the trade to even out payables and receivables.
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